Put your lender’s hat on. Wouldn’t it be great if you could prevent your borrower from filing bankruptcy in the first place? Unfortunately for lenders, a recent decision demonstrates how hard it is to prevent bankruptcy filings.

In In re Bay Club Partners-472, LLC, 2014 Bankr. LEXIS 2051 (Bankr. D. Or. May 6, 2014), the debtor was a manager-managed Oregon limited liability company which owned an apartment complex. In order to acquire the property, the debtor had borrowed approximately $23 million from the lender’s predecessor in interest. The debtor’s operating agreement contained a provision prohibiting the company from filing bankruptcy until it had paid back the loan. This provision was included in the operating agreement at the request of the lender. There was no such bankruptcy prohibition contained in any of the loan documents.

After the bankruptcy filing, the lender filed a motion to dismiss the bankruptcy petition on the grounds that the operating agreement prohibited the filing. After finding that the lender had standing to file the motion, the court nonetheless ruled that the provision in the operating agreement prohibiting the filing was against public policy and unenforceable. While this ruling should not have been much of a surprise given prior appellate court rulings in the Ninth Circuit, what was particularly troubling from the lender’s perspective was the court’s criticism of its tactics. The court found that the lender had been “cleverly insidious” by choosing not to include the bankruptcy prohibition in the loan agreement, but requesting that it instead be included in the operating agreement. This, the court found, was “no less the maneuver of an astute creditor to preclude [the company] from availing itself of the protection of the Bankruptcy Code.”

Interestingly, the court found that representatives of all members of the debtor had signed the operating agreement containing the bankruptcy prohibition, but that there was no evidence that the members had discussed the prohibition.

Where does this leave lenders? Clearly, lenders face an extremely uphill battle arguing in favor of the enforcement of bankruptcy prohibitions. However, the battle is not insurmountable. The likelihood that a bankruptcy waiver will be enforced increases to the extent that:

  • the bankruptcy waiver is made at a time when the company is not under duress;
  • there is no evidence of coercion by the lender;
  • the company availed itself of counsel in the negotiations over the waiver; and
  • the bankruptcy waiver is conspicuously set forth in the loan documents.

Nonetheless, no lender should count on a bankruptcy waiver being enforced. Instead, the prudent lender should insist on the “normal” protections afforded a secured creditor, namely sufficient collateral.